On 18 January, the Bank of Japan (BoJ) held its Monetary Policy Meeting (MPM) and in a unanimous vote decided to maintain the status quo across all monetary policy parameters, including YCC and asset purchase programs. The BoJ also maintained forward guidance, which is tied to the pandemic situation and states that it “expects short- and long-term policy interest rates to remain at their present or lower levels.”
Below we look at what this means for the market and for Japanese equities.
Market speculation since December on the termination of YCC
Market speculation on the sustainability of YCC increased sharply after the BoJ surprised by widening the tolerable band for 10-year Japanese government bond (JGB) yields to around +/- 0.5% at its MPM in December 2022. Since then, the distortion of the yield curve and market dysfunction has deepened as the 10-year yield broke through the 10-year yield upper limit a few times, leading to speculation on the termination of YCC. The 10-year swap market suggests that 10-year yields could rise to 1.0%. Considering the hawkish expectations going into the meeting, the announcement in January was a dovish surprise to the market.
Chart 1: YCC bands, JGB yields and swap rates
Source: Bloomberg, as at January 2023.
Gradual normalisation of monetary policy reflects a solid economic backdrop and higher CPI
The economic backdrop in Japan has been solid, with the economy forecasted to grow at 1.3%1 in 2023. Inflation has picked up with the November Consumer Price Index (CPI) reading at 3.8%. The BoJ has revised up its CPI outlook for 2024 from +1.6% to +1.8%, and has also pointed out that risks to inflation are skewed to the upside. Given the combination of (1) higher CPI (2) growing distortion in JGBs and (3) the preference from the Kishida administration for policy normalisation, we believe the BoJ will gradually normalise its monetary policy. The next step will likely be to end YCC and the negative interest rate policy.
YCC removal likely by June 2023
We believe YCC removal will likely be in place by June 2023. Although we cannot rule out the possibility of the BoJ making a change at the next meeting in March, the market is expecting changes to be made in or after April. Announcements are unlikely in March as 1) March is the end of the fiscal year which is a sensitive time to make policy changes 2) the new BoJ leadership will be confirmed in February so we expect a gap before new policies are announced 3) the BoJ will wait for Shunto spring wage growth figures, announced in March, before it makes policy changes. One way to forecast the timing of the event would be to monitor the BoJ’s funds-supply market operation, the scope of which was expanded in December 2022. This operation encourages financial institutions to purchase JGBs. Currently, the BoJ’s high ownership of JGBs has contributed towards the yield curve distortion.
With regards to the new BoJ governor, there are three main candidates; current Deputy Governor Amamiya, former Deputy Governor Nakaso, and former Deputy Governor Yamaguchi. The first two are expected to stay on a similar course to Kuroda, while an appointment of Yamaguchi, who has been perceived to be more hawkish, may shock the market.
Financials are the most correlated sector with JGB yields
The rise in the 10-year JGB from 0.1% in January 2022 to 0.4%2 currently has benefitted the financial sector, most notably banks. We assume the gradual change in BoJ monetary policy could boost bank stocks’ P/B multiples by strengthening ROE upside and normalising (lowering) cost of equity.
Chart 2: One-year (r-squared) correlation of share prices with 10-year JGB yields
Source: CLSA, Bloomberg, as at January 2023.
Japan reopening stocks and consumer staples stocks expected to do well
The widening of YCC and the prospects of monetary policy normalisation have led to the Japanese yen appreciating to 130 yen to the dollar. A stronger yen would generally benefit domestic exposed stocks, as lower import costs provide margin relief. We see good opportunities in consumer staple names, which should benefit from price increases in the unprecedented inflationary environment, with material costs coming down. Reopening stocks are expected to perform well as Japan has opened to international tourism and domestic spending remains solid.
Normalisation of monetary policy could lead to a renewed interest in Japanese equities
Foreign buying of Japanese equities has declined significantly in the last few years, as the weak Japanese yen has been a drag on performance. For 2023, Japan is among the fastest growing of the G7 countries. Japanese stock markets remain under-owned by foreign investors and Japanese markets trade at attractive valuations.
Chart 3: Consensus forecasts for G7 real GDP growth
Source: Bloomberg, as at January 2023.
Chart 4: 12-month forward P/E versus ten-year average
Source: Bloomberg, as at January 2023.
The combination of solid economic growth and the gradual normalisation of monetary policy could lead to a renewed interest in Japanese equities.
We look forward to discussing events in Japan, and our disciplined approach to high conviction investment ideas, as the year progresses.